One of the most common questions I’m asked from clients is, “can my lender sue me after foreclosure in San Diego?” Generally, your lender cannot sue you on a 1st mortgage, but it may be able to sue you on a 2nd mortgage or home equity line. Here’s how after foreclosure liability works, and the effect of a San Diego bankruptcy filing on such liability:
Can My Lender Sue Me After Foreclosure?
In California, there are what is called “antideficiency” laws that protect you in the event of a foreclosure. (Other states also may have different rules, and the “antideficiency” laws of many states are very similar to California law.) Antideficiency laws curtail your lender’s ability to sue you for a deficiency balance after a foreclosure sale of your home. A deficiency balance means the difference between the amount that you owed on your home loan or equity line of credit and the amount your lender was able to obtain by selling your home at foreclosure.
Fair Value Limitation Rule
The way the antideficiency laws protect you is through the Fair Value Limitation rule. The rule essentially states that if your loan was a purchase money loan (that means you used the money to purchase your home), which is typically the case, then your lender cannot sue you after a foreclosure sale in San Diego.
Your lender is limited to collecting the loan balance by selling your home at a foreclosure sale and recovering whatever it can obtain through the foreclosure. That’s it.
The reason for the Fair Value Limitation rule is to place a check on brokers and lenders so that they are not writing loans for more than the value of the real estate security for the loan. By placing the risk of inadequate security on the lender, the Fair Value Limitation rule aims to ensure that brokers and lenders to not overvalue real estate when making a loan.
Fair Value Limitation Not Applicable for Rental
If your loan was for a rental property or other property that was not used as your home, then the Fair Value Limitation rule does not apply. In such a situation, your lender has two options.
Option 1: Your lender can foreclose by private foreclosure sale under the Deed of Trust that you gave your lender, in which case it cannot later come and sue you because the antideficiency laws also provide that one your lender elects to foreclose and does foreclose your lender cannot later sue you for a deficiency.
Option 2: Your lender can bring an action in Court for judicial foreclosure, which is a very rare occurrence (lenders usually elect to conduct private foreclosure sales under a deed of trust), and in such an action can obtain both a judgment of foreclosure and a money judgment for a deficiency against you.
1st Mortgage – Home Loan
Because of the Fair Value Limitation rule, your lender will never sue you on a 1st mortgage home loan. It will simply foreclose.
2nd Mortgage – Sold Out Junior Lender
If you have a 2nd mortgage or equity line of credit, the Fair Value Limitation rule usually will not apply.
The test is to see whether the loan was for purchase money or not. If the 2nd mortgage was a purchase money loan, for example 100% financing (also called 80/20 financing, referring to a 1st position mortgage loan for 80% of the value of the property, and a 2nd position loan for 20% of the property value), then the Fair Value Limitation rule applies.
But if you had a 2nd position loan, such as a home equity line, that was not used for purchase money, the Fair Value Limitation rule does not protect you. After your 1st mortgage lender does a foreclosure of your home, the sold out junior lender (who had the 2nd position loan) can sue you in Court and obtain a judgment against you for the full unpaid balance of the loan.
If your lender has already sued you, filing bankruptcy will stop the lawsuit and eliminate the debt, assuming that you qualify for bankruptcy relief. By eliminating the underlying debt, filing bankruptcy will protect you from any future lawsuits as well.
Exception to Sold Out Junior Lender Rule
There is one little known exception to the sold out junior lender rule. The sold out junior lender rule was created to protect junior lenders whose liens were wiped out due to no fault of their own. If both the 1st and 2nd position loans are held by the same lender, the lender cannot foreclose on the 1st loan and then sue you for the balance of the 2nd loan. In that case, the holder of the 2nd loan is not sold out through no fault of their own. The lender had full control of whether or not to foreclose, and was wiped out by their own doing.
So, a lender holding both a 1st and 2nd position loan cannot do a foreclosure sale, knowing that its 2nd loan will be wiped out, and then turn around and sue you for the balance of the 2nd loan.
But if the holder of a 2nd loan or equity line of credit was wiped out based on the foreclosure of another lender, and the loan was not for purchase money, then the sold out 2nd mortgage or home equity line lender can sue you after foreclosure. In that case, you will need to file bankruptcy in San Diego to eliminate your liability to the sold out junior lender.
Even if your lender does not sue you, it may still write off the 2nd mortgage and issue you a 1099C for the canceled debt, in which case you may incur tax liability. By filing bankruptcy San Diego, you will eliminate 1099C liability.